Tata Motors back in favour on JLR margin performance, premium equity issue

Mumbai: Tata Motors shares soared 18% to ₹150 in Sunday’s Diwali ‘Muhurat’ trade. The jump in the stock was in response to the company’s strong September quarter (Q2FY20) performance, as a result of which, US-listed shares of the Indian carmaker had surged 13.2% on Friday.

Two factors inspire confidence that prospects of the global auto company may be improving.

First, Tata Motors’ ₹583 crore profit before tax, at the consolidated level, as opposed to Bloomberg’s consensus estimate of a ₹1,600 crore loss for the quarter and compared with a loss in the year-ago quarter took the market by surprise. Improved operating performance and the impact of a better product mix on sales at its UK-subsidiary Jaguar Land Rover Ltd (JLR), that has been a drag for last several quarters, also buoyed sentiment.

Second, the preferential share issue to promoter Tata Sons Ltd at ₹150 a share was at a significant premium to the market price - ₹126 on Friday – and will boost the stock in the near term.

More importantly, analysts appear convinced that JLR’s 13.8% earnings before interest, tax, depreciation and amortization (Ebitda) as a percentage to its sales was not a flash in the pan. Ebitda margin was not only 480 basis points (bps) higher year-on-year but was among the best in 16 quarters and a big leap from the June quarter margin that slipped to 4.2%.

The 480 basis points (bps) margin gain is the result of continuous improvement in retail sales in China. Trimming of work force, optimizing marketing costs, along with lower commodity cost aided profitability. Even the FY20 cost saving target of 2.5 million British pounds has almost been achieved.

According to Mitul Shah, vice-president-research, Reliance Securities Ltd, who is positive on JLR’s prospects explains, “JLR should be able to maintain double-digit margins with better volumes and falling commodity cost. The management expects raw material cost to go down further in 2HFY20, as negotiation with vendors is under process."

As for the ₹6,500 crore infusion by promoters, it would reduce leverage of the firm, hence improve the debt to equity ratio.

All this, however, is not to say that there are no concerns.

Developed markets of US, UK and Europe have shown a moderation in growth rates. In the analysts’ call, JLR indicated a UK-plant shutdown for about a week ahead of Brexit, which is a looming risk to business prospects of JLR and Tata Motors as a whole.

Further, the pain in its standalone business has continued. Sales of medium and heavy commercial vehicles have remained under pressure given the demand slowdown, which analysts forecast will last another few quarters. The revenue drop in excess of 40% both in commercial vehicles and passenger vehicles dragged standalone Ebitda margin down to 3.8% from 11.4% a year ago.

But the good thing is that the company has cut its product stock worth ₹3,500 crore, bringing down inventory to realistic levels. Therefore, Tata Motors’ consolidated Ebitda margin of 12.4% on the back of a bounceback in JLR’s performance looks sustainable, calling for a re-rating in valuation following sustainable earnings growth.

As a report by Antique Stock Broking Ltd’s puts it, “achieving the guided 3-4% earnings before interest and tax margin FY20/21 is within visible range now and ₹6,500 crore fund infusion by promoters at 150/share through shares and convertibles provides needed funding cushion."